Thursday, October 29, 2009

Goodhart vs. Kay

“Narrow banking is not the answer to systemic fragility” writes Charles Goodhart who develops some good arguments against the narrow banking proposal in his October 28 Financial Times column here .

He is wrong however on one point at least: being in favor of smaller, more specialized banks, as an objective for the future, after a reform of the system, is not the same thing as claiming that financial authorities should not have helped large diversified banks avoid bankruptcy in the recent past. The impact on the economy would have been devastating given their sheer size, and it is precisely for that reason that banks should be compelled to downsize and re-specialize in the future. The failure of one or a few smaller investment banks would then not jeopardize the whole economy, which is the main point of the "too big to fail" reform proposal.

He then argues that in a narrow banking system, depositors would shift their funds towards risky financial institutions during relatively safe periods, only to return to safer institutions when risks increase, and thus would exacerbate the cyclical instability of the economy. But that would not be the case if investment banks were not allowed to manage current payments for depositors, just as corporations in general are not allowed to manage the payments needs of their shareholders.

Blogs I Like

Good Value For Your Reading Time

About Me

As a professor of economics, my main specialization fields are in the theory and strategy of the firm, and the theory and applications of public choice (political economy).
I also do consulting work in these fields.
For more information on my work go to my homepage: http://jeanjacques.rosa.pagesperso-orange.fr/
and my SSRN author page: http://ssrn.com/author=471576.
My e-mail has changed: jj.rosa@orange.fr